Cash Credit vs. Overdraft: What’s the Difference?

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Cash Credit vs. Overdraft: What’s the Difference?

Cash credit and overdraft are two forms of short-term lending available to consumers from financial organizations. Both are used to prevent checks from bouncing or debit cards from being refused when checking accounts do not have enough cash. The main distinction between various types of borrowing is how they are secured.

Business accounts are more likely to acquire cash credit, which usually needs some type of collateral. Overdrafts, on the other hand, let account users to have a negative balance without paying a significant overdraft charge.

Key Takeaways

  • Both cash credit and overdraft relate to credit lines with a lender.
  • Overdraft accounts of various forms enable customers to hold negative amounts while avoiding high overdraft penalties.
  • Cash credit is more common in business and usually includes some type of collateral.

Investopedia / Sabrina Jiang

How Cash Credit Works

Cash credit is often extended to corporations rather than individuals. In return for cash, financial organizations such as banks and credit unions often ask a business client to deposit some type of security as collateral. This security may be a physical asset, such as shares or real estate. The credit limit on the cash credit account is typically a proportion of the collateralized security’s value.

As previously stated, cash credit is a short-term lending option available to business customers. If the customer’s account is insufficiently funded, they may utilize the cash credit for ordinary banking transactions up to the credit limit. In contrast to other types of credit, interest is imposed on the daily closing balance.

Cash credit is also known as a cash reserve account. A cash reserve is an unsecured line of credit that functions in the same way as overdraft protection (see more below).Because penalty penalties are not triggered for using the account, it often has greater overdraft limits and lower actual interest charges on borrowed cash than an overdraft.

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What’s The Difference Between Overdraft And Cash Credit?

How an Overdraft Works

Overdraft is a kind of financing provided to people by a financial institution and is linked to a bank account—typically a checking account. If a customer’s account does not have enough money to execute a transaction, the overdraft pays the difference, enabling the account to slip into negative balance. Assume Mr. Jones has $500 in his account and writes a check for $550. In rare situations, the bank may allow him to overdraw his account to pay the check, resulting in a -$50 balance.

Overdraft protection refers to the procedure of extending short-term credit to an account customer when their balance falls below zero. Overdraft protection is available in a variety of ways, each of which acts differently depending on the banking connection. Overdraft protection often connects two accounts, enabling cash to be automatically drawn on a reserve account if the main account is pulled below zero. This feature may assist you avoid overdraft penalties or having insufficient cash to complete a transaction.

If a customer’s account does not have overdraft protection, banks levy a fee of up to $38.50 per overdraft plus interest on the sum. Overdraft protection may also be marketed as a second unsecured line of credit linked to the main account, operating as a loan in the case of an overdraft. Overdraft fees are not charged with this sort of overdraft protection, but interest is charged on the credit line amount.

Types of Overdraft

Overdrafts are classified into two types: regular overdrafts on checking accounts and secured overdraft accounts, which lend money against different financial products.

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Standard overdraft

A typical overdraft is the withdrawal of more cash from an account than the balance ordinarily allows. If you have $30 in your checking account and withdraw $35 to pay for an item, a bank that allows overdrafts will cover the $5 and usually charge you a little fee for the service, rather than a much bigger overdraft penalty. Customers are often charged a fee for any transaction that exceeds their account balance, however fees are handled differently by various institutions.

Secured overdraft

A secured overdraft functions similarly to a typical loan. A financial institution lends money in the same way as a cash credit account would, but a broader variety of collateral may be used to secure the credit. Customers may be permitted to utilize mutual funds or equity shares, for example.

Clean overdraft

There is also a clean overdraft account, in which no particular collateral is required, but an overdraft is granted owing to the individual’s net worth. In general, this is only achievable if the borrower has a substantial account with the financial institution and has a long-standing connection with them.

While a business’s cash credit is typically extended yearly, an account holder’s access to overdraft protection is evaluated annually and may or may not be re-approved.

Special Considerations

Customers who can supply some type of collateral may be able to readily get cash credit, which means they won’t have any liquidity issues if they need funds quickly. Cash credits are often extended on a yearly basis for business clients. This eliminates the need for firms to reapply for loans. Because cash credit interest payments are tax deductible, companies may utilize them to reduce their tax burden and save more money in the long term.

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If a consumer wishes to add overdraft protection to their account, they must apply for it just like any other credit facility. The application is reviewed by the bank, and acceptance is contingent on the customer’s creditworthiness. On a regular basis, banks evaluate whether to continue providing overdraft protection to a client. Customers cannot claim interest paid on overdraft protection as a tax deduction, unlike cash credit.

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